[Opinion] Intricacies in Valuation for Angel Tax | Analysis Through Judicial Pronouncements

CA Anil Chachra – [2024] 162 taxmann.com 227 (Article)

1. Introduction

Section 56(2) (viib) [“Angel Tax”] was introduced from the A.Y. 2013-14 as a measure to prevent generation and circulation of unaccounted money. When the clause in section 56(2)(viib) of the Income Tax Act [“Act”] is read in tandem with elucidations provided in CBDT Circular no 3/ 2012 dated 12-06-2012; the intentions behind such insertion and also Memorandum explaining Finance Bill 2012, it appears that whole thrust for such insertion is to bring measures to tax hefty or excessive share premium received unjustifiably by private companies on issue of shares without carrying underlying value to support such uncalled for premium and thereby enriching itself without paying taxes legitimately due to them. It also seems that subscription to the shares issued by a company at a substantial premium (not necessarily backed by a valuation justifying the premium) was supposedly resorted to convert unaccounted money. The extant framework of law was not found sufficient by the legislature to curb such practices. The provision was inserted to change the landscape for charging premium to tax of capital nature. Hence the share premium in excess of fair market value of shares to be treated as income of the company. The provisions will not apply if the company substantiates that the fair market value has been determined on the basis of the value of its tangible and intangible assets. The fair market value to be calculated as per Rule 11U and 11UA. Rule 11UA(2) states that the valuation will be done at the option of the assessee. Two methods [Either as Discounted cash flow or Net Asset Value] has been specified for Resident Investors and five methods have been specified for the Non-Resident Investors. So, the valuation plays a very vital role while issuing the shares by the company. By doing the valuation as per this section read with rule 11UA become the litigative issue. In this write up we will analyse the applicability of this section and its valuation principles through judicial pronouncements.

2. Section 56(2) (viib) – Legal Analysis

Before delving further, lets understand the section 56(2) (viib) first.

Section 56(2) (viib)- Relevant Extract

“Where a company not being a company in which the public are substantially interested receives in any previous year from any person [being resident- deleted w.e.f 1-4-2024] any consideration for issue of shares that exceeds the face value of such shares, the aggregate consideration received for such shares as exceeds the fair market value of such shares. [Emphasis Supplied]

On the perusal of the above it is evident that where a company [not any other persons like firms or LLP] in which public are not substantially interested [can say private companies] receives any consideration for issue of shares [ can be equity or preference shares] that exceeds the face value of shares [which will be calculated as per Rule 11UA] the aggregate consideration received for such shares as exceeds the fair market value of shares [FMV] will be treated as deemed income.

As per the memorandum of the finance bill, 2012 it appears that whole thrust for such insertion is to bring measures to tax hefty or excessive share premium received unjustifiably by private companies on issue of shares without carrying underlying value to support such uncalled for premium and thereby enriching itself without paying taxes legitimately due to them. The intention of the introduction of this section was to counter the unaccounted receipts in the form of black money.

The Income Tax Department [“Department’] while doing the scrutiny of the companies normally ask for the justification of the valuation done by the companies. Hence, the valuation done by the discounted flow method [DCF] which will be on the estimated or projected numbers plays a pivot role in the assessment proceedings. So, doing the valuation which will be at the option of the assessee become the litigative area. The questions which arises are whether the AO can reject the valuation made by the assessee and replaced with own method or can the AO appoint his own valuer for the valuation purpose or the actual numbers which is available at the time of the assessment can be replaced with the estimated numbers etc.

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